A Scary Movie: Filling Your 401(k) With Company Stock

We’ve seen the movie before, when employees of Enron and Lehman Brothers lost large sums of money in their 401(k) plans because of investments in company stock. And now, coming to a theater (and, inevitably, a courtroom) near you, is a sequel, surely not the last, this time featuring RadioShack.

The company filed for bankruptcy protection last month, after years of lackluster interest from customers who once flocked to the stores for their doodads and gizmos. The company’s stock trades over the counter for spare change, after a slow-motion disintegration over the last five years.

In September, when the stock was still worth a small handful of quarters, the company stopped allowing employees to invest in it through their retirement plan, but employees filed suit, claiming that the company should have shielded them from the damage sooner. The Department of Labor has begun its own inquiry as well.

So the lawyers and the bankers are now the protagonists, as they have been in all of these movies. But an obvious question lingers: Why do so many companies and employees keep signing up to be a part of all this drama?

Employer stock in 401(k) plans is less common than it used to be, but it’s still in plenty of them. According to Aon Hewitt’s 2013 survey data, 39 percent of employers offer their stock as an investment option. Among those companies, 12 percent go much further, requiring that the employer match of workers’ contributions from their paychecks be in company stock. Most let employees swap it for something else right away, but inertia often keeps them from doing so.

The Plan Sponsor Council of America, using a different data set, lays out the results of such policies: When employees have the option (or are required because of a match) to invest in company stock through a 401(k) plan, a fair number do. On average, about 18.1 percent of assests are invested that way, while the median is 13 percent. At least the number of companies where more than half of the 401(k) plan assets are in company stock has fallen over time; in 2004 it was 13 percent, but in 2013 it was just 2.2 percent.

Why do companies allow and encourage such investments? There were once plenty of good theories. If employees owned a lot of stock, they might vote their shares with management if hostile forces were trying to take the company over. And encouraging employees to have skin in the game is good, as it gives them incentive to work hard and rewards them for greater effort.

The data related to these theories can be counterintuitive, though. In 2013, David Blanchett, the head of retirement research for Morningstar Investment Management, found that companies with higher allocations of employer stock in their 401(k) plans tend to underperform their peers in the year after that overweighting exists. His theory: Employees increase their allocation to the stock after the stock performs well, just in time for it to reverse course.

There are many negatives to allowing employees to invest in their own company in their retirement plans. Let’s start with the stipulation, which shouldn’t be necessary but clearly is anyway, that these are retirement plans. Some employers offer stock grants or bonuses as a form of extra compensation, and that’s fine. Others let employees gamble on their employer’s shares through an employee stock purchase plan that is separate from a 401(k), occasionally offering a small discount on the purchase. There, workers use discretionary money of their own if they so choose, and hey, if you want to turn your office into a trading floor, so be it.

But we’re talking about people’s golden years here — and trying not to tarnish them with enormous losses. When an employer offers up its stock (let alone matches contributions with it) as an option, it’s effectively an endorsement, an implicit statement from the employer that this investment is a reasonably good idea. Otherwise, why would it be on the 401(k) menu? Once it’s there, employees who think they know more about their employer than they do about the mutual funds on the menu (a perfectly reasonable supposition) will be tempted to overweight their 401(k) contributions toward the employer stock fund.

All of this, however, is incredibly risky. When you’re getting your income from an employer — and your livelihood literally depends on that company — it makes little sense to make a big bet on the company stock with money that you’ll need if you ever want to stop working when you’re old and gray someday.

Employees do this anyway, however, and they do not seem to get themselves out of the investments even when the warning signs are already all around them.

A paper by the academics Ying Duan, Edith S. Hotchkiss and Yawen Jiao studied 729 troubled publicly traded companies over 20 years and found that the amounts of money that employees had in company stock remained relatively stable during periods of trouble, as did their new contributions. This is true even as the stock prices decline and the number of investors betting against the stock in the public markets through short sales increases.

This is what seems to have happened at RadioShack, where the average number of shares that employees held through the 401(k) plan increased in recent years even as the company’s share price fell steadily. The lawsuit will determine whether the company should have stopped its employees from making what turns out to have been a foolish bet.

The message of this and other movies like it is clear for employees: Don’t do this. If your employer matches your 401(k) contribution in company stock, set a calendar alert to remind yourself to sell it a few times each year and then reinvest it. If your employer restricts your ability to sell it right away and makes you keep it for a few years, complain loudly to human resources; most companies don’t do that anymore.

Even if an employer stock fund is one choice among many in your 401(k) plan, ask yourself this: Given the employment risk you already face by getting your income from a single source, do you really want to bet even part of your retirement money on that company? How much do you really know about its prospects, its competitors and forces way beyond your control? And how much are you willfully blind to?

If you’re one of the many people who weighs in on the investment menu for your company’s retirement plan, think hard about simply getting rid of the company stock plan altogether, or at least capping the size of the bet that delusional employees can make on the company stock. Might the stock price take a hit once word gets out? Perhaps, but you can couple the change with a strongly worded news release that you’re doing this only to force workers to diversify their retirement investments and that your employee stock purchase plan and stock grants for executive compensation purposes continue unabated. The chief executive could even buy a bunch more stock in the open market that very day.

The bottom line is this, or it should be at least: If you were a financial planner and your clients had a chunk of retirement account money in the stock of their employer, you’d tell them to cut it out, without hesitation. It’s not even a close call. Given that, your colleagues shouldn’t be betting their retirement money on your employer either.

A version of this article appears in print on , Section B, Page 1 of the New York edition with the headline: The Scariest Stock to Put in the 401(k). Order Reprints | Today’s Paper | Subscribe